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Subdued housing market activity in the UK

House prices in UK are still rising, at least in nominal terms (i.e. not adjusted for inflation). But uncertainty over Brexit is clouding the market's prospects.

For the fifth consecutive quarter, London saw a house price drop, declining by 0.7% (-3.1% inflation-adjusted) during the year to Q3 2018, with falls of up to 15% for some top-end central London properties. Despite these declines in the capital's house prices, Nationwide's Chief Economist Robert Gardner noted that London's prices are "still more than 50% above their 2007 levels".

The average house price in the UK rose by 2.1% to £216,103 (US$ 279,227) during the year to Q3 2018, according to Nationwide - a slowdown from price increases of 2.2% in Q2 2018 and 2.5% in Q1 2018. However, when adjusted for inflation, house prices actually fell by 0.4% y-o-y.

The highest price rise was in Yorkshire and Humberside, with house prices rising by 5.8% during the year to Q3 2018. It was followed by East Midlands (4.8%), Northern Ireland (4.3%), West Midlands (4.2%), and North West (4.1%).

The Outer Metropolitan Area around London actually fell by 0.4%, while prices in the North dropped by 1.7%. Regions with weaker price rises also included the South West (1.9%), Scotland (2.2%), East Anglia (almost 3%).

In October 2018, national house price growth was at its lowest since May 2013 at 1.6% y-o-y, according to Nationwide's recent report. Aside from economic uncertainty, respondents of the RICS's UK Residential Market Survey in September 2018 also cited stock shortage, affordability constraints, and recent interest rate hikes as factors restraining the market. RICS's survey respondents were pessimistic that sales activity will pick-up in the coming months.

"As we enter quarter four, the market remains suppressed, which is likely to continue into 2019. A deal on Brexit is required to give some certainty, which will then encourage investors and purchasers," said Richard Taylor of London's Surveyors &amp; Valuers.

The UK's and particularly London's previous dramatic house price rises were fuelled by four factors:

Immigration and population growth have been strong, especially in London.

Interest rates have been at record lows, with a large expansion of the money supply through "quantitative easing".

The City of London (London's financial centre) continues to boom.

Construction activity remains weak (though this is less true of London).

House prices in the UK are expected to increase by around 1% in 2018, according to Gardner. Activity will likely pick-up if uncertainty clears, but for now weak economic activity, and affordability constraints, are dampening the housing market's activity and price growth.

There are no restrictions on foreign ownership of properties in the UK.

London's yields are low

London's residential prices have stopped rising in the higher-end districts. But London remains by any measure extraordinarily expensive.

That impacts rental returns, since rents have not risen as much as prices. Gross rental yields, i.e., the gross annual rental return on an investment in an apartment if fully rented out, are now quite low in London.

A 50 square metre (sq. m.) apartment in prime central London is likely to cost you £750,000. If rented out, it will give you a gross rental return of around 3.2%

A 120 sq. m. apartment in prime central London is likely to cost you £2,200,000. If rented out, it will give you a gross rental return of around 2.6%

Yet surprisingly, larger apartments sometimes have higher yields - particularly in the more expensive districts of London. This defies the almost universal rule in other cities that smaller flats have higher rental returns. Why is it now different in London? Because of the UK's amazingly high stamp duties on super-expensive property purchases, which are dissuading high-flyers from buying. People prefer to rent if they are staying just a few years, because the total costs of renting high-end properties are lower than the total costs of buying and then selling them. High capital gains taxes on sale, and worries about Brexit, reinforce the message that in London, renting now makes sense for the rich.

To get the picture, look at our table and at the high-end districts. In Knightsbridge and Kensington, rental returns on 1 bedroom apartments are 2.7%, but returns on 3 bedroom apartments are 3.2%. However before you leap in, to buy your 3 bedroom Kensington apartment will cost you a cool £4.2 million!

The highest yielding 3 bedroom apartments appear to be in W1 (Mayfair, Marylebone and Soho). These areas have traditionally been popular with the Arab market, and a 3 bedroom apartment can earn 5.3%.

Foreign residential property investors in Britain have long faced a rising rumble of discontent from the British public about exorbitant housing prices in London, which rightly or wrongly is partly blamed on the large numbers of foreign buyers, as well as the continuous flow of immigrants into London. Both are hot-button issues.

One result is that foreign buyers are now liable to capital gains taxes when they sell their UK properties (previously they were exempt). Another is that stamp duty has been ramped up on higher-end properties. There is talk of further measures - it is widely agreed that Council Tax is too low on high-end properties, and the Liberal Democrats have been agitating for a mansion tax.

Effective tax rates are moderate in the UK

Rental Income: Unless nonresidents take specific steps, they will be taxed on net rental income ssourced from the UK at a flat rate of 20%, which must be withheld by the tenant or letting agent. However, effective tax rates can be brought down to around 9% with all the allowable deductions.

Capital Gains:Capital gains are taxed are taxed at progressive rates, from 18% to 28%.

Inheritance: Estates or assets exceeding the current tax threshold of £325,000 (€433,333) are subject to inheritance tax at 40%. In calculating the amount of the estate, the value of any gifts made by the deceased within 7 years of death must be added (some small gifts are exempt).

Residents: UK residents are taxed on their worldwide income and on capital gains from disposal of their UK assets, and most likely on their overseas properties too.

Roundtrip transaction costs moderate in Britain, can be high on high-end properties

Total roundtrip transaction costs range from 3.90% to 12.16%. Almost all buyers, UK-based or not, employ lawyers as well as real estate agents. Legal fees are around 0.5% to 1% while agent's fees are around 2% to 3.5%, plus 17.5% VAT.

UK law is pro-landlord

Rents: Landlords and tenants can freely agree on rent levels. They can freely agree any mechanism of increasing rent levels. Deposits are lawful.

Tenant Security: Contracts naturally revert to a standard monthly contract which, after an initial six month's period of security of tenure, allows the tenant to be evicted at two months' notice. However in practice the eviction process can disadvantage the landlord.

Slower expansion expected in 2018; Withdrawal Agreement still in limbo

The UK economy grew by 1.7% in 2017, the country's weakest expansion since 2012, according to the Office for National Statistics (ONS). This weaker growth followed 1.9% economic growth during the year of the Brexit vote in 2016.

The UK's GDP growth per capita figures are unimpressive. In 2017, GDP growth per capita was 1.2%, following per capita GDP growth of 1.1% in 2016, 1.5% in 2015, 2.3% in 2014, 1.4% in 2013, 0.8% in 2012, and 0.6% in 2011, according to the International Monetary Fund (IMF).

In general, the UK's recovery since the recession has been anaemic, at best. In previous recessions, there was above average growth. For instance in 1983 GDP grew by 4.2%, and in 1994 by 3%. The UK's growth mostly relies on its services sector, according to Office for National Statistics (ONS).

The Bank of England (BoE) expects an even slower economic expansion in 2018 at around 1.3%, to be followed by a 1.7% growth in 2019.

"The outlook for growth, employment and inflation depends significantly on the nature of EU withdrawal, in particular: the form of new trading arrangements between the EU and UK; whether the transition to them is abrupt or smooth; and how households, businesses and financial markets respond," says the BoE's November 2018 Inflation Report.

In November 14, 2018, a draft text of the Withdrawal Agreement between the UK and the European Union was agreed upon by officials of both parties, as reported by the BBC. The EU27 nations then approved the Brexit deal during a special summit held in Brussels on November 25. However, the agreement is still subject to the approval by Parliament, who will vote on the deal on December 11, 2018.

While ratifying the agreement would reduce uncertainty and could assure economic growth in the short term, the agreement itself contains some parts that might hinder the Parliament's approval. One is the Irish backstop, a last resort effort to maintain an open border between the Republic and Northern Ireland, which would come into effect if both the EU and the UK fail to reach a free trade deal before the transition period ends in December 2020. The backstop could lead to Northern Ireland being more aligned to the EU, creating a different customs regime in the area than the rest of the country.

Northern Ireland's Democratic Unionist Party (DUP), which supports UK Prime Minister Theresa May's minority government, has already indicated that they are against the backstop. DUP leader Arlene Foster said in an interview on BBC's Andrew Marr Show on November 25 that the party "cannot support this deal".

Prime Minister May has already rejected the backstop proposal and proposed a "Chequers plan" in July 2018, creating a free trade area for goods and scrapping customs checks between the UK and the EU. However the Chequers Plan will not work, according to European Council president Donald Tusk.

According to Ireland's deputy government head Simon Coveney, if the British government doesn't support the draft Withdrawal Agreement's wording on the backstop, then they should propose "a viable and legally operable alternative wording that delivers same result: no border infrastructure". The EU's position is that there will be no withdrawal agreement and transition period after Brexit, if there's no agreement on the backstop.

The UK is scheduled to officially leave the EU on March 29, 2019.

In the July to September 2018 period, the UK's overall unemployment rate was at 4.1%, slightly up from the 40-year low rate of 4% in August, but still a bit down from 4.3% a year earlier, according to the ONS.

The UK's inflation stood at 2.4% in October 2018, down from 3% in October 2017.